How to Lower Portfolio Risk with Currencies
Diversification is the best way to reduce portfolio risk. It has long been understood that spreading your capital wisely can save you from unexpected asset deterioration, but exactly how to do that needs to be reconsidered.
There are a host of new products available to individual investors. Traditionally, people have been told that buying stocks and bonds is good enough to build a diversified portfolio. Still others, who really think they’re savvy, spread their bets into small, mid, and large cap stocks. These people may even buy variable maturity debt securities, such as long and short term Treasuries or municipal bonds. While these techniques are a good start, the modern investor should use all the tools at their disposal, not just what worked in the past.
It’s easier than ever to pick up the same kinds of exotic investments as the most sophisticated hedge fund in days of yore. Regular people can now include all types of commodities (from agricultural to energy and everything in between), currencies, and select stock sectors in their portfolios simply by purchasing exchange-traded funds (ETF’s).
Currencies, in particular, offer individuals a powerful alternative for hedging inflation and the decline of the US dollar, and adding a new level of diversification to offset adverse movements in stocks and bonds.
Negatively correlated assets held in the same portfolio reduce overall risk. Risk, as measured by variance of returns, can actually be lowered simply by holding assets that do not move in the same direction. For instance, if stock A decreases 70% of the time stock B increases, and vice versus, then you could construct a portfolio that has less total risk than either A or B by including both.
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